No time to waste as IBOR transition reforms loom

11 September, 2019

From the European Central Bank to the Federal Reserve convened Alternative Reference Rates Committee (“ARRC”), from the Financial Conduct Authority (“FCA”) in the UK to the Australian Securities & Investments Commission (“ASIC”), the recent messaging across the globe is clear – it is essential to start your IBOR (Inter Bank Offered Rate) transition planning now. While the ECB recently sent a Dear CEO letter to 114 large credit institutions in Europe seeking assurance that the risks associated with this reform are understood, the message applies to all firms with IBOR exposures.

The scandals that engulfed LIBOR (London Inter Bank Offered Rate) led to reforms that, while providing stronger oversight and administration of the widely used benchmark, ultimately failed to address the core issue - the lack of sufficient activity in the underlying market that LIBOR seeks to measure. LIBOR is a forward-looking rate only partially based on actual transactions, instead relying on expert judgement. Because of this, they are open to manipulation.

The FCA’s Andrew Bailey has stated that the FCA would no longer compel panel banks to submit to LIBOR by the end of 2021 and that the discontinuation of LIBOR is something that will happen. While it is possible that a “zombie” LIBOR could exist in some capacity post-2021, without the involvement of the FCA (and the reticence of the Panel Banks to continue to submit), it would not be considered sufficiently robust or accurately reflect activity within the market. Other IBORs face a similar fate as they do not satisfy IOSCO guidelines on benchmark-setting processes, specifically Principle 7, which states that a reference rate should be based on an active market and actual transactions.

Alternative Reference Rates (“ARRs”) have been identified to replace the existing IBORs.

Existing IBOR rate(s)	Proposed alternative benchmark	Borrowing type	Administrator
GBP LIBOR	Reformed-SONIA	Unsecured	Wholesale Markets Brokers’ Association (WMBA) transitioning to Bank of England
USD LIBOR	SOFR	Secured	Federal Reserve Banks of New York (FRBNY)
EUR LIBOR, EURIBOR	ESTER	Unsecured	European Central Bank (ECB)
CHF LIBOR	SARON	Secured	SIX Exchange
JPY LIBOR, TIBOR	TONAR	Unsecured	Bank of Japan

These ARRs have unique challenges. Increased liquidity is a necessity to help form more robust benchmarks. Additionally, some are secured rates, while others are unsecured. With different administrators of each benchmark, they publish at differing times during the day. There are also no term rates as yet for any of the ARRs.

What do firms need to do

Given the significant notional value (and volume) of financial product contracts that reference IBORs and the vast array of financial products linked to these reference rates, firms must proactively manage the transition to the ARRs promptly. Early implementation of transition plans, which should include budgeting, time and headcount, is crucial to allow a full review of existing contracts that will identify contracts that require updating.

Firms should also begin to use the identified ARRs moving forward to reduce exposure to IBORs, which should protect firms from getting caught in the expected liquidity gap that will arise as more firms adopt the ARRs closer to the end date for LIBOR and other IBORs.

What must firms consider when determining their transition plan? The FCA issued feedback relating to their ‘Dear CEO’ letter on LIBOR transition that gives firms a strong indication of the level of preparation and actions that are required.

The FCA recommends a detailed assessment of the level of interaction between the business and IBORs, that details the balance sheet exposure and any impact on pricing, risk and valuation models. They also outlined that the stronger responses included considering a range of quantitative and qualitative tools and metrics to effectively monitor IBOR exposures and related risks.

Additionally, clear governance and a detailed transition plan are recommended, with key milestones and deadlines right up to the end of 2021. Firms should also ensure that wide-ranging risk assessments, aligned to effective mitigation actions, are conducted and prioritised accordingly. Firms are also encouraged to participate in industry group consultation papers and working groups where possible. Finally, firms are encouraged to start using the new ARRs, or at least ensure that robust fall-back language is incorporated into their contracts.

Planning and budget discussions should start now

Firms must begin to mobilise their governance and PMO and ensure that they are budgeting for their transition from now until the end of the transition process, with due consideration to understanding who will bear the costs. Firms should also be looking to commence an impact assessment as soon as possible, looking at contract discovery, analysis and remediation. They should also begin the process of client outreach planning. The end is nigh for IBORs. There is no time to waste.

How PwC can help

We can help you assess, prepare for, and execute on the transition by using our proven approach, supported by our tools and leveraging off our global experts. We work with you across the entire lifecycle of the transition, including: